- The business tax rate cut under Trump's proposal would likely be good for real estate agents' and brokers' bottom line.
- Concerns from NAR remain about the effective elimination of the mortgage interest deduction and the future of homeowner taxes (and home values) under the proposal.
Last year, Ways and Means Republicans in Congress put together what the committee called a “blueprint” for tax reform. Titled “A Better Way Forward On Tax Reform,” the document outlined how Republicans thought taxes could (and should) be tweaked — and it has noteworthy similarities with the tax plan that the Trump administration released during the campaign for the Presidency last year, too.
Like Trump’s campaign tax plan (and the reform plan that’s currently being discussed by Ways and Means Republicans), “A Better Way Forward” makes the following changes:
- It reduces the number of tax brackets from seven to four.
- It changes how individuals claim tax benefits. Instead of using basic and additional standard deductions — and personal exemptions for taxpayers, spouses, and children and dependents — benefits would be consolidated into a larger standard deduction and an “enhanced” child/dependent credit.
- It would eliminate all itemized deductions except for two: the mortgage interest deduction (MID) and the charitable giving deduction. “These two provisions help accomplish two important goals that strengthen civil society: homeownership and charitable giving,” states the blueprint.
The proposed tax plan would also reduce the business tax rate significantly, from an upper limit of 39.5 percent to a flat rate of 15 percent — something anyone in business is excited about, and which could offer a financial boost for real estate agents.
However, the National Association of Realtors (NAR) released a strong statement last week that questioned whether this tax proposal would really help homeowners. In particular, NAR said that the tax plan would effectively eliminate the MID and therefore “would effectively nullify the current tax benefits of owning a home,” according to NAR President Bill Brown.
Jamie Gregory, deputy chief lobbyist at NAR, spoke with Inman about NAR’s position on the tax reform plan and shared some exclusive early numbers from an analysis by NAR and PricewaterhouseCoopers (PwC), which indicate that middle-income earners would be on the hook to pay more taxes while home values drop.
A boost for real estate businesses
As Aaron Lesher wrote in “Trump tax plan update: A boon for real estate agents?”, there’s one proposed rule change that could significantly benefit real estate agents: The proposal to “allow pass-through entities like LLCs, partnerships and S Corporations to pay a flat 15 percent business tax, rather than tax income at personal rates.”
The current business tax rate is 35 percent (as most broker-owners probably know very well), but real estate agents, as independent contractors, typically pay taxes at a personal rate.
If agents set up their business as a “pass-through entity” — a partnership, LLC (limited liability corporation) or S corporation — then they can take advantage of the flat 15-percent business tax, too. This could be a good move for agents to make right now, Lesher notes.
He calculates that an agent grossing $100,000 per year who sets up a pass-through entity would net a 6.2 percent profit increase under the proposed tax reform — and that an agent grossing $100,000 per year who doesn’t use a pass-through entity would still take home 2.15 percent more in profit.
The luxury real estate sector would especially benefit from the proposed tax changes — high-end homeowners will likely still take advantage of the MID, and being able to keep more of their wealth in their pockets means more money that luxury consumers can invest in real estate.
Some tax experts also think that this change could make C corporation status more desirable for current S corp businesses, which could give brokers and other real estate companies more options when setting up their businesses.
“Most small businesses are deterred from C corporation status because it imposes two levels of taxation on the same income,” wrote CFO.com’s Matthew A. Morris in November. “Thus, a reduction in the corporate tax rate to 15 percent would remove a significant disincentive to selecting C corporation status during entity formation, and may also prompt certain S corporations to abandon their S corporation status.”
Could increased personal wealth trickle-down and therefore offset the potential negative effects that NAR and PwC see in the housing market? With the significant personal and business savings that could result from this tax reform, it’s a compelling argument.
Why the plan could dis-incentivize claiming MID
After “A Better Way Forward” was released last year, Gregory says the big question at NAR was: “What would this mean for homeowners — and thus for our members?”
“It wasn’t clear,” Gregory said, “and we felt like we needed to dig a little deeper.”
They started with deductions.
“The main thing that both the blueprint and the Trump proposal clearly do is they keep charitable deductions and mortgage interest deductions, but they eliminate everything else, including state and local deductions,” he added.
Here’s how deductions would change under the blueprint:
Current 2016 standard deduction
|For singles||For heads of household||Married filing jointly|
Proposed standard deduction
|For singles||For heads of household||Married filing jointly|
“In the speaker’s own analysis that he put out with the blueprint, fewer than 5 percent of tax filers would itemize,” noted Gregory — because almost doubling the standard deduction makes it much more attractive to most taxpayers, including homeowners.
Mortgage-holders who are spending a boatload on interest (luxury homebuyers who finance their purchases, for example) might find that their itemized deduction, including the MID, would be a better deal than the standard deduction — but anyone who isn’t spending tens of thousands of dollars on interest every year would be better off taking the standard deduction.
“If you’re not itemizing, you’re not using the MID,” explained Gregory, “so ergo you’re taking away the incentive — so ergo you’re making no difference between renting and owning.”
What would that do to homeownership, NAR and PwC asked?
The effects of the deduction changes
“If you’re taking away the incentive to claim the MID, people may rent longer,” posited Gregory. “We found that people in the middle, with incomes between $50,000 and $200,000 a year, would pay an additional $800-plus a year in taxes.
“Now, that may not sound like a lot,” he added, “but homeowners already pay the majority of the revenue that’s taken in by tax filers.”
And those additional taxes also wouldn’t make it easy to save up for a down payment on a home, which is already a struggle for many first-time homebuyers.
Another data point related to the analysis: NAR and PwC calculated that home values would drop 10 percent under the proposed tax reform.
Why ask PwC about what could happen to home values under the tax plan? Because of home value projections made by academics the last time a remotely similar reform plan was floated.
“The last time we had a debate similar to this was in the mid-’90s, when then-leader Dick Armey proposed his flat tax idea,” Gregory explained. “We had a significant analysis done, and there were several academics who did their own and who said there would be a severe drop in home values — 15 percent nationally, and as high as 20 percent to 25 percent in high-value sales.”
So NAR posed the question, and PwC estimated that due to decreased demand and fewer incentives to buy, home values would take a 10-percent hit.
Past is prologue?
The problem, posits Gregory, is not necessarily lowering the rates — it’s changing the deductions. Rates are malleable, but sweeping shifts like that can be hard to undo if they turn out to be a bad move.
“If you want to learn from the 1986 Tax Reform Act, which everyone seems to be pointing to — the ’86 tax act took the top business tax rate from 39.6 percent to 28 percent,” Gregory noted.
“Three years later, at the big budget summit held out at Andrews Air Force Base, under George Bush 41, the rate went up to 33 percent. Then, later, under Clinton, it went back to 39.6 percent.
“So I guess the point is: You can’t bind future Congresses,” he added. “You could do away with all these incentives and the economic benefits of homeownership all in the name of lowering the rates — but once the rates go back up, the MID and state and local deductions aren’t coming back. It would be a double-whammy for homeowners.”
And he also wasn’t sure that agents would entirely benefit from the proposed business changes, either.
“As independent contractors, the agents are filing in probably the most complex part of the code, and we don’t know what’s going to happen in that space,” Gregory said.
He added that NAR is working on its talking points for the upcoming Realtors Legislative Meetings & Expo, taking place the week of May 15.